Fu Yu Corporation Limited (SGX:F13) trades with a trailing P/E of 32.5x, which is higher than the industry average of 10.1x. While this makes F13 appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Fu Yu
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for F13
Price-Earnings Ratio = Price per share ÷ Earnings per share
F13 Price-Earnings Ratio = SGD0.19 ÷ SGD0.006 = 32.5x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as F13, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. F13’s P/E of 32.5x is higher than its industry peers (10.1x), which implies that each dollar of F13’s earnings is being overvalued by investors. Therefore, according to this analysis, F13 is an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your F13 shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to F13. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with F13, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing F13 to are fairly valued by the market. If this does not hold, there is a possibility that F13’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on F13, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following: